JP Conklin 704-887-9880 office jp.conklin@pensfordfinancial.com www.pensfordfinancial.

com Leveling the Playing Field June 18, 2012 _______________________________________________________________________ So after a week at Lake Lure with the kids, I came back to the following schedule: Friday night: hosted a sleepover Saturday: baseball from 10am until 3pm for the 8 year old boy; dance recital at 6pm for the girl Sunday: baseball games at 10am and at 3pm (Happy Fathers Day!) Something tells me you guys can appreciate how good it will feel to get back to work and relax a bit! Greek Elections If Syriza wins, markets will tank, right? This is the socialist party that is flat out telling anyone who listens that they will voluntarily default as soon as they are in power. So of course markets tank. But maybe instead the market will believe a Syriza victory forces a global, coordinated response and paradoxically translates into a risk-on mentality on Monday. Or maybe Im just making stuff up out of left field at this point.

Controlled Market Crash We all recognize that Germany is the most critical European country in the recovery, so perhaps we should look to the biggest German bank for guidance on what to expect? Here is an overview of a report from Deutsche Bank to resolve the Spanish crisis: 1. Liquidity injection by the ECB with looser collateral provisions (JPs question: how much good collateral does Spain really have?) 2. Announcing recourse to the EFSF rather than the ESM to recap Spanish banks and send a signal to markets that seniority (or subordination depending on vantage point) is not a hurdle 3. Direct recapitilization of banks by a modified version of the ESM With the market unconvinced by the Spanish bank recap package and near-term prospects of an ERF unconvincing, the market will be looking to the ECB as a last resort to restore some order. The ECB is similar to our FOMC, setting policy, collateral guidelines, etc AND taking the risk of default by borrowers. In the recent LTRO (long term refinancing option)

bailout, the ECB basically made euros available at 1.00%. Spain and Italy borrowed the most money and used the funds to buy their own government bonds. Some sort of LTRO or other mechanism will be unveiled in the near future. But that doesnt address one glaring issue: what about deposits? If the FOMC and ECB are peers in my overlysimplicstic analysis, what is the eurozone equivalent of the FDIC? The short answer is that there isnt one. Strong, large economies like Germany and France didnt want to guarantee the deposits of countries like Greece.oops. Good call. But they did create something called Emergency Lending Assistance, or ELA. The ECB makes money available for the national central banks to use but it remains an obligation of the central bank, not the ECB (unlike the LTRO, where the ECB is on the hook). The Financial Times ran a story about how the ELA used to be its own line item on the ECB balance sheet but that it has recently been moved into the Other category. The FT also reported that this line item has ballooned to over 150 billion.

So what does this mean? Even when the ECB declines a loan to a particular bank (like it did to some Greek banks) for inadequate collateral, the bank just turns to its friends at its own central bank, which in turns taps the ELA and voila! Everyone pretends the bank is still solvent. Stay with us here, almost done.

To summarizeELA loans are guaranteed by the Greek central bank, which is guaranteed by the Greek government, which cant pay its debt without a bailout. So, do you provide a bailout? Of course you do, you dont want a full blown crisis! But like any reasonable lender, you do so with restrictions and parameters and hurdles and benchmarks and austerity measures andand whats that? Come again? Ummm, the possible incoming party said you will give it a no-strings bailout or it will default on existing borrowings? And you will do it and like it!? Now what do you do? It would take two-thirds of the eurozone central banks to shut Greece out from the ELA, which means Greece needs only five friendly votes to keep the ELA window open. But even if you shut them out successfully, you basically just voted to shut down the Greek banking system and everyone starts to wonder if youll do the same to Spain, Italy, Portugal, etc Im reminded of a scene from the movie Liar Liar with Jim Carey where he is arguing with the tow truck guy about a new (huge) scratch in the car. Tow Truck Guy: Oh, that scratch? That was already there. Jim Carey: LIAR! You know what Im going to do about this? Greece: What?!?! Eurozone: Nothing! Because if I take it to small claims court, it will just drain 8 hours of my life and you probably wont show up and even if I got a judgement youd just stiff me anyway, so what I am going to do is piss and moan like an impotent jerk and then bend it over and take it up the tailpipe! Greece: Youve been here before, havent you? So Europe (mostly Germany) pays for the Greek mess because theyll get dragged down anyway. But 600 million a day is leaving Greek banks, or about 2% per week. Does anyone smell a run on the banks? And by now you should know what question is coming next: If this is Greece now, who is next?

FOMC Meeting When was the last time an FOMC meeting was rendered largely irrelevant? We think the Fed got caught off guard a bit in the last few weeks/months by softening domestic economic data. They have been cautiously optimistic for the last two quarters, citing domestic resiliency in the face of global headwinds. But last weeks releases just reinforced the notion of a weakening domestic economy. Empire Manufacturing, consumer confidence, and industrial production all came in weaker than expected.

In the April economic projections, the FOMC forecasted growth to hit 2.7% in 2012. The problem is that Q1 came in at 1.9% and most economists have already revised their own forecasts down from the 2.5 range to sub-2.00%. If GDP ultimately comes in around 1.8% or 1.9% in Q2, wed need to see 3.5% over the second half of the year to hit Aprils forecast. This means we expect a downward revsision for GDP by the FOMC this week. And drumroll please.more quantitative easing! Remember, Operation Twist is set to expire at the end of the month, so extending this program is the most likely outcome. But dont be surprised if we get a signal that QE3 is around the bend.

Fixed Rate Outlook A coordinated, global central bank intervention is still the greatest threat to current rates, but even if that is the case are you all warm and fuzzy after reading this far? Me neither. Maybe thats why the 10yr Treasury auction on Wednesday set an all-time low yield of 1.622% with a similar bid-to-cover (measure of demand) as recent auctions. This Week Greek elections, Eurozone issues, and the FOMC meeting all suggest a very volatile week ahead.

ECONOMIC CALENDAR
Economic Data Day Monday Tuesday Time 10:00AM 8:30AM 8:30AM Wednesday 7:00AM 12:30PM Thursday 8:30AM 8:30AM 10:00AM 10:00AM 10:00AM 10:00AM Report NAHB Housing Market Index Housing Starts (MoM) Building Permits (MoM) MBA Mortgage Applications FOMC Rate Decision Initial Jobless Claims Continuing Claims Philadelphia Fed Existing Home Sales (MoM) House Price Index (MoM) Leading Indicators 0.25% 385k 3280k 0.0 -1.3% 0.4% 0.1% Forecast 28 0.4% 1.0% Previous 29 2.6% -7.0% 18.0% 0.25% 386k 3278k -5.8 3.4% 1.8% -0.1%

Speeches and Events Day Wednesday Time 12:30PM 2:00PM 2:15PM FOMC Rate Decision FOMC releases Projections of Economy and Fed Funds Rate Fed's Bernanke holds Press Conference Report Place

Treasury Auctions Day Time Report Size

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